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TheStreet Open House

New ETF Offers Protection Against Rising Rates

NEW YORK (TheStreet) -- The bond market is becoming increasingly difficult to navigate as any positive economic news lead to fears that the Federal Reserve will start reducing its monthly asset purchases -- the so-called tapering -- causing bond prices to fall and interest rates to rise, and which is what happened last Friday when employment data was released.

The new Pro Shares Investment Grade Interest Rate Hedged ETF (IGHG) is the latest fund trying to offer protection against rising rates, but is the first fund to protect an investment grade portfolio. Like other hedged bond funds, IGHG has two portfolios side-by-side: The investment grade bond portfolio and a combination of short positions in various U.S. treasury futures contracts.

The bond portfolio component of the fund is a very simple, investment grade corporate portfolio. It is well diversified with 457 holdings of both domestic and foreign bonds; the foreign bonds are dollar denominated.

The sector breakdown favors financials at 32%, followed by industrial-service at 20% and industrial-manufacturing at 17%. The sector makeup is generally in line with more mainstream corporate bond ETFs likes the iShares iBoxx Investment Grade Corporate Bond ETF (LQD).

The current weighted average maturity of the portfolio is just under 15 years. The hedge strategy will target the same maturity as the bond portfolio and, for now, that is done with 55% short 10-year futures, 33% short 30-year futures and 12% in the Pro Shares Ultra Short 20+ Year Treasury ETF (TBT).

It's too early for any specific yield information for the fund, but the fact sheet notes the average coupon in the fund is at 5.13%, and that the average price for the bonds in the portfolio is $107.62 which gives a rough estimated yield of 4.76% for the index. Subtracting the 0.30% expense ratio for the fund could put the yield near 4.46%. However, there will likely be a drag from the cost of maintaining the hedge against rising interest that could further reduce the yield.

Another risk factor is that interest rates could go back down. That is not a prediction so much as an acknowledgement that interest rates went far lower than most people expected in the face of unprecedented Fed policy -- one which is likely to remain in place for several years.

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